94 Quarterly Bulletin 2016 Q2 The demise of Overend Gurney By Rhiannon Sowerbutts of the Financial Stability Strategy and Risk Directorate, Marco Schneebalg of the Major UK Deposit Takers Supervision Directorate and Florence Hubert of the Monetary Analysis Directorate.(1) • 150 years ago, Overend Gurney, the largest discount house in the City of London, suspended payment. The Times immediately christened this date ‘Black Friday’ due to the financial panic that ensued. The failure of Overend Gurney was caused by a change of business model, whereby it entered the lending business but with poor lending practices and insufficient risk management. • The Bank of England, a private bank at the time, refused assistance to Overend Gurney but supported the refinancing of viable banks and brokers by depleting its own reserves. Over a ten-day period, the bill discount rate (the Bank Rate of the time) was increased four times to 10%. Financial stability returned in the following months. • This lending by the Bank of England led to valuable debates around optimal central bank lending and limited liability and inspired Walter Bagehot’s principles for lender of last resort. There are several lessons which remain relevant today. Overview The failure of Overend Gurney — a discount house which On 9 May 1866, Overend Gurney asked the Bank of England had been larger than its three next largest competitors for assistance, which was refused on the basis of the broker’s combined — sent shockwaves through the financial system in insolvency; Overend Gurney suspended payments at May 1866. The seeds of its demise had been sown many 15.30 on 10 May 1866. years earlier. Despite its profitable bill broking business, Overend Gurney had been on the brink of failure for some To mitigate the panic that followed the Bank of England, a time, incurring enormous losses from the bad loans it had private bank at the time, extended the largest market-wide extended with little credit risk assessment. In 1865 in an lending it had ever done and drew heavily on its own attempt to salvage Overend Gurney, its partners had reserves. Bagehot praised the Bank for accepting its lender converted the broker to a limited liability company. But of last resort role, setting an expectation that the Bank ultimately, the combination of more generalised economic would act in the same fashion in similar circumstances instability, some unfortunate rumours and a court case in the future. The best way to carry out central bank which ruled they could not collect from a debtor pushed lending has been the source of academic and policy Overend Gurney into failure. debate ever since. The rise of Overend Gurney The demise of Overend Gurney 1775 1807 1850 1857 1858 1859 1860 1865 9 May 1866 10 May 1866 Creation of Overend Gurney is larger than the Financial panic, allayed after Overend Gurney Conversion Overend Gurney Overend Norwich bank next three biggest bill brokers Bank of England lends to orchestrates a run on of Overend asks the Gurney as part of combined and turns over bills equal bill brokers and the the Bank of England. Gurney from Bank of England suspends Gurney & Co. to half the United Kingdom’s Banking Act is suspended. The run is unsuccessful. unlimited for assistance payments national debt each year. to limited which is refused at 15.30. liability on the grounds Creation of bill broker The Bank of England restricts bill brokers’ Expansion into longer-term company. of insolvency. Overend Gurney. access to its Discount Window Facility. lending with very poor underwriting standards. (1) The authors would like to thank the Bank of England Archive, Ian Bond, Forrest Capie, Andrew Hauser, Sarah John, Matthew Manning, Aniruddha Rajan and Peter Thomas for their help in producing this article. Topical articles The demise of Overend Gurney 95 On 10 May 1866, 150 years ago, Overend Gurney, one of the initial promise. For example, a bill of exchange with a face largest bill brokers in the City of London, failed. The run on value of £10 could be sold for £9.50, meaning a discount rate Northern Rock plc in September 2007 has often been of 5%; this effectively represented the interest rate the third compared to the panic that ensued after the failure of party would receive for taking on the risk that the merchant Overend Gurney. would not repay the debt. The demise of Overend Gurney marks a turning point in Overend Gurney, as a bill broker and discount house, thus Britain’s financial history. In its aftermath, it led to valuable enabled lenders seeking to obtain funds before the due date of debates concerning the Bank of England’s role as the their loans to sell their bills to commercial banks with excess lender of last resort (LOLR) and moral hazard. Lessons from deposits. The box on page 96 gives an account of the market these debates remain relevant today — not least those found for bills, the London Discount Market, and its relationship with in the 1873 treatise by Walter Bagehot (Editor in Chief of the Bank of England, which at this point was a private bank. The Economist at the time) on the principles for LOLR in Lombard Street: a description of the money market. Figure 1 The rise of Overend Gurney 1775 1807 1850 This article looks back at these events. The first section discusses the rise of Overend Gurney and their initial core Creation of Overend Gurney is larger than the business of bill broking. The second section examines its Norwich bank next three biggest bill brokers decline and eventual failure. The third section discusses the as part of combined and turns over bills equal Gurney & Co. to half the United Kingdom’s actions the Bank of England took to help stem the panic national debt each year. caused by Overend Gurney’s failure. Finally, the article Creation of bill broker highlights the debates and lessons that remain important Overend Gurney. today. Under the leadership of Samuel Gurney, Overend Gurney became the largest and most influential of the four major The rise of Overend Gurney discount houses of the middle of the 19th century. Bagehot noted that it ‘stood next to the Bank of England in the In 1775, the Gurney family of Norfolk, prominent merchants in City of London; it was better known abroad than any similar the wool trade, expanded its business to banking in the firm’. By the 1850s, it had accumulated deposits equal to prosperous farming district of East Anglia. The family did so those of its three main competitors combined and its annual by creating what later became ‘Gurney & Co.’, a bank which turnover of bills of exchange was equal in value to about half facilitated investing in London, drawing on their Quaker the United Kingdom’s national debt. reputation to attract the savings of the local gentry and tradesmen. The Gurney family had a reputation for An uneasy relationship between the Bank of England trustworthiness and wealth, both particularly important and the bill brokers prerequisites for running a bank as these were run as unlimited The first half of the 19th century had been plagued with liability partnerships. recurrent panics in the money market (1825, 1837–39, 1847 and 1857) following large credit expansions. To stem the Gurney & Co. successfully grew to become the largest bank in panics, the Bank of England had typically provided liquidity to East Anglia. In 1807, Samuel Gurney (the heir of the original the market but with a delay. The 1844 Bank Charter Act founder of the Gurney & Co. bank) further expanded the limited the number of Bank of England notes in issuance to family business by acquiring and restructuring the London the value of its gold reserves and this needed to be suspended bill broker ‘Richardson, Overend & Company’, and so the to enable the Bank to provide the needed liquidity in the combined company he founded became known as market, unconstrained by the total stock of gold it held. ‘Overend, Gurney & Company’. It was one of the first In the event, the fact that the Bank of England was able to companies to offer, for a brokerage fee, to match buyers and provide liquidity often provided sufficient confidence to sellers of bills of exchange, the major financial instrument of the market. the time. Overend Gurney then quickly became a discount house, as it also started investing in the market for bills on its In 1857, bank failures in the United States caused several own account. failures in the United Kingdom, in what became known as the first worldwide financial crisis. The panic this caused in the Bills of exchange were promises by one party (the borrower) United Kingdom led to a surge of applications for assistance to pay another party (the lender) a specified sum of money from bill brokers to the Bank of England. Overend Gurney was (the ‘face value’ of the bill). The lender could then sell these one of the largest beneficiaries of this assistance, partly by bills to third parties at a ‘discount’ to the face value of the virtue of its size in the market. 96 Quarterly Bulletin 2016 Q2 Bill broking, the discount market and the banks’ bills of exchange. This was in addition to ‘Advances’ Bank of England also provided through the Discount Window (see Figure 4). The discount rate the Bank of England charged on those bills is in some sense similar to the Bank Rate the In the middle of the 19th century, bills of exchange were the Monetary Policy Committee sets today. main financial instrument. They were used to record most business transactions and could be traded.